What is an offset mortgage and how much money could it save me in tax?

A rarely used tax-efficient tool might benefit you if you have a fair amount of cash savings

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Last month’s Budget has made saving less rewarding. Tax on interest is rising, cash ISA limits are shrinking, and frozen thresholds are pushing more of us into higher tax bands. For those with sizeable cash balances, finding a tax-efficient home for that money is becoming trickier.

One option that has had little attention in recent years is the offset mortgage. It’s a niche product, but the new tax rules may mean more people should consider it.

“The announcement that savings income will be taxed at a new higher rate from April 2027 will no doubt boost interest in offset,” says David Hollingworth from L&C Mortgages.

“With cash ISA limits being reduced as well, those that still want to hold cash may like the idea of effectively earning the mortgage rate on their savings and with no interest being earned there is no tax to pay.”

Sounds ideal - so what exactly is it?

What is an offset mortgage?

An offset mortgage puts your savings in an account linked to your mortgage. Yours savings earn no interest, but are deducted from what you owe on your mortgage, so you pay less interest on your debt.

As an example, if you have a £400,000 mortgage and £100,000 in your linked savings account, you only pay interest on £300,000.

You could of course simply overpay your mortgage with that £100,000. But the advantage of an offset mortgage is liquidity – you can still access your money if you need to, but when you don’t need to, it can work to reduce your overall interest bill.

The Government is being urged to scrap Lifetime Isa penalties for first-time buyers in the autumn Budget as it emerged some savers are being charged at least £11,000 to withdraw their cash (Joe Giddens/PA) (PA Wire)

“Offset mortgages can be very tax-efficient, particularly for higher and additional rate taxpayers,” says Karen Noye, mortgage expert at Quilter. “When you earn interest on savings, tax is deducted once your personal savings allowance is used up.

“By contrast, using that same cash to reduce the balance on an offset mortgage means you save mortgage interest instead, and this saving is not taxed.

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“For someone paying 40 or 45 per cent tax on their savings interest, that can make a meaningful difference to the effective return they receive.”

Who should consider an offset mortgage?

Offset mortgages don’t work for everyone. In general, you need to have a large amount of savings, have used up your tax-free savings options and pay a high level of income tax. For people with smaller balances or room left in their ISA allowance, traditional savings may make more sense.

Also, fewer lenders have offset mortgage products, and they tend to have higher interest rates than the best deals on standard mortgages.

To see when an offset mortgage makes sense financially, let’s take a £250,000 mortgage with 15 years left. We’ll compare keeping savings in an account paying 3 per cent while paying a 4 per cent mortgage, versus offsetting the same cash against a 5 per cent offset deal.

With £100,000 in savings, offset is the clear winner for higher and additional-rate taxpayers.

How much could I save with an offset mortgage?

A higher-rate taxpayer would pay £43,556 in interest on the mortgage over five years while earning £10,561 on their savings after tax. So, their net interest cost would be just under £33,000. In contrast, they would pay £27,000 interest on their offset mortgage – a saving of £6,000.

Additional-rate taxpayers see an even better return with offsetting because more of their savings return is lost to tax. Even basic-rate taxpayers are better off at this level, by around £3,000.

At £75,000 in savings the gap narrows.

(Getty Images)

Higher and additional-rate taxpayers still gain by offsetting – around £1,600 and £3,200 respectively in this example – but a basic-rate taxpayer loses money with an offset and would be better off keeping the savings separate.

Cut the amount in the savings account down to £50,000 and the offset no longer wins for anyone. The interest saved on the mortgage isn’t enough to outweigh the higher interest rate on the offset mortgage.

These calculations use today’s tax rules and don’t factor in the higher tax on savings coming in from April 2027. The tax on savings will rise to 22 per cent for basic rate, 42 per cent for higher rate and 47 per cent for additional rate taxpayers. Then the offset advantage will grow for people who have maxed out their other tax-free savings options.

But you still need to factor in the different interest rates you can get on savings accounts, standard mortgages and offset mortgages, or what returns you think you could get if you invested the money instead - which would again involve questions of liquidity.

“Whether it’s worth paying the higher mortgage rate will depend on what level of tax you pay, how much you have in savings, and whether you plan to spend any of those savings during the period of the mortgage,” says Sarah Coles, head of personal finance at Hargreaves Lansdown. “You will need to do the maths to see if it works for you.”

Offset mortgages will never become mainstream, as for most people the usual savings routes are more straightforward. But for higher earners with large cash balances who are running out of tax-free shelters, an offset could be an efficient home for their money.

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